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Corporate finance

Sensitivity analysis: A solution for managing uncertainty?

September 5, 2022

Minimum wage set at $18? Nitrogen fertilizer prices doubling? Droughts impeding yields 6 out of 10 years? A pandemic undermining supply chains? Interest rates skyrocketing after years at rock-bottom? A great deal of variables affect farming businesses. Sensitivity analysis is the best way to manage uncertainty by testing companies’ financial resilience.

These 2 words might scare people, but should in fact reassure them. That’s because behind a sensitivity analysis, whether done on a piece of paper, in a spreadsheet or through specialized software, are scenarios to face the headwind. “It’s an essential component of risk management,” says Agronomist and Market Analyst Marjolaine Carrier. “This should be a routine step when developing an investment project or preparing an annual operating budget,” adds René Gagnon, Agronomist and Director, Agriculture and Agri-Food Markets.

For this pair of Desjardins Agri-team members, farm businesses must take interest in sensitivity analyses. No need for a 28-variable matrix to develop 327 probabilistic scenarios in a theoretical document! With the help of its account manager, any business can use both income and expense data to see the effect on profitability. “It’s easier to account for contingencies when you first calculate the cost of production,” says René Gagnon. “You can then easily modify an expense percentage or interest rate and see the effect on finances. This is especially true in the agricultural sectors, which have no price-fixing power or cannot transfer the economic impacts to consumers.”

The more things change, the less they stay the same

Both agronomists believe fluctuations could be expected in the coming years. Modelling to detect business vulnerabilities will be more important than ever. Climate crises, carbon taxes, global events, labour shortages, and rising interest rates are all unpredictable factors that could test entrepreneurs’ financial strength. “Those who analyze their sensitivity will respond better and more quickly,” says Marjolaine Carrier.

Agronomist Jean-François Drouin, Senior Economist at the Centre d’études sur les coûts de production en agriculture, cautions that more changeability on more variables is also needed. “With the pandemic, the only reliable forecast is that no forecast is reliable! This context highlights the importance of keeping up with developing costs and finding innovative solutions to adapt.” He calculates that the cost of livestock food increased by about 15% between 2021 and 2022, and 20% in the previous year. In terms of crop production, fertilizer costs increased from 50% to 100%, depending on the time of purchase and the type of fertilizer, which hurts.1 “On the bright side, commodity prices remain generally favourable for the time being, but cost increases remain substantial, with little time to adapt,” he concludes.

Conducting a sensitivity analysis is key to strategically understand the essential factors for the profitability of your business. This will make it easier to observe variations that can have major consequences, so you’ll have every opportunity to avoid them in the event of significant fluctuations.

1. According to recent CECPA External link. This link will open in a new window. publications (French only)